A R121 million underwriting swing knocks profits at Mutual & Federal

A R121 million swing in the underwriting result has combined with a big dip in unrealised investment income to shave 69% from Mutual & Federal’s (M&F) headline earnings for the six months to June 2008. During the presentation chief executive Keith Kennedy went to great lengths to highlight the few positives to an attentive audience...

He said that despite the drop in headline earnings the group was in a position to declare an unchanged dividend (45c per share) for the first half of 2008. Over 20 years M&F remains one of the JSE’s best dividend payers. He also noted that operating earnings were only 16% lower at 126c per share versus 150c for the corresponding period. This was a better measure of performance as it smoothed out volatility. But nothing can change the facts. Shares in the company are languishing some way below the R25 per share seen at the beginning of the year. Back then Royal Bafokeng Holdings was keen on buying Old Mutual’s 70% stake – today things are very different indeed.

Underwriting margins in free fall

So what’s the problem? Kennedy presented a graph of the underwriting surplus for major insurers going back to 1993. It’s clear from this graph that the industry is currently in the latter stages of a downward underwriting trend. From highs of 12.1% in 2004 the average underwriting surplus has fallen to just 4.9% this year. Kennedy believes that the short-term insurer should aim for at least 4% to adequately compensate shareholders. And that’s not great given M&F’s 2.6% for the first six months of 2007 and even worse (-0.8%) performance in the first half of 2008. The question on everyone’s lips is simply this: Why is M&F’s underwriting performance so poor?

There are a number of factors which affect claims and have a knock-on impact on the underwriting result. These include crime, weather, driving standards, infrastructure, road conditions, risk management, economic pressures and inflation. A closer analysis of these categories reveals where M&F has taken strain in recent times. With vehicle theft and hi-jacking on the decline, in line with national police statistics, it turns out that the big impact on M&F in the latest period came from commercial claims, weather claims and group schemes.

The total value of weather claims increased significantly in the first six months of 2008. Using a graph to compare the ‘size’ of claims Kennedy showed that this category cost the group R379m this year, compared with R291m in 2007 and R288m in 2006. The average value of large commercial claims (M&F lumps any claim in excess of R5m in this category) was also higher. In the first half of 2007 the group paid 19 claims for a total of R244m. This year the number increased to R392m over just 21 claims. The average has gone up from R12.8m per claim to R18.6m!

On group schemes and the restructure

The company faced a number of challenges in its group schemes business. Kennedy identified the five major concerns. Increasing claims ratios, abnormally high claims inflation, deteriorating incidence of loss, reluctance to accept rate adjustments and limited control over client data meant that M&F was struggling with the parts of its business managed by delegated authorities. The battle for underwriting profit from Group Schemes has been ongoing since Q1 2006. Initial remedial action seemed to be working; but Group Schemes bled R76m to June 2008. Strong action had to be taken.

M&F subsequently cancelled a number of Group Schemes where claims ratios were in excess of 75%. Kennedy admits that the decision to cut R600m in annual premiums was not taken lightly. But he also noted that carrying businesses where the claims ratio was in excess of the 71% break even made absolutely no sense…

The company will save a further R130m per annum in salary reductions after a reorganisation. 625 jobs will be shed as M&F migrates from a head-office with approximately 50 national offices to a business with three main regions (Johannesburg, Cape Town and Durban), a central processing hub and a strong national sales presence.

Old Mutual insists on parting ways...

The poor results were overshadowed by a cautionary announcement issued to coincide with the half-year results. Major shareholder Old Mutual announced that it would sell its entire holding in M&F during September. The transaction would take place as a ‘competitive sale’ process. Old Mutual will basically ‘auction’ its 74% stake to the highest bidder... The timing of the announcement seems a bit unusual. Surely Old Mutual shareholders would be better served if the company waited for an improvement in the financial sector before dumping the shares. M&F shares hardly moved on the news, trading 0.7% higher one hour after market open.

Editor’s thoughts:
Mutual & Federal boasts around 17% of South Africa’s short-term insurance market… But latest results show that even an experienced company can run into unexpected problems. To management’s credit steps are being taken to stop the slide. Do you think the M&F restructure and decision to cancel group schemes will halt the decline in profit? Add your comment below, or send it to gareth@fanews.co.za